Recently it looks like traders can’t miss. The S&P retains setting new highs whereas volatility has been comparatively low.
However one thing nonetheless doesn’t really feel proper. So I assumed I’d check out what’s really taking place underneath the floor.
And one chart specifically caught my eye as a result of it tells me that this rally is operating on borrowed confidence.
As you possibly can see, U.S. margin debt simply climbed to a brand new all-time excessive.
What does it imply for you and your portfolio?
When folks borrow extra to purchase shares, it normally means they’re feeling assured. Typically that confidence is justified. Different occasions, it’s a warning signal.
On this case, it is perhaps each.
Borrowed Cash Is Powering the Market
Again in July, I informed my Excessive Fortunes readers that: “We’re in a low-volatility, grind-higher part led by retail momentum.”
That hasn’t modified.
On the floor at present, all the pieces appears okay. Shares maintain climbing and company earnings appear stable.
In different phrases, the trail of least resistance proper now’s to take a “maintain regular” method.
However beneath the floor, rising margin debt is like including accelerant to a fireplace.
When traders purchase on margin, they’re amplifying their exposures. Meaning wins will be greater, however so can losses.
In a quiet, regular rally that’s wonderful. However the second volatility ticks up or market sentiment sours, that leverage turns into an issue quick. If we get hit with shock inflation numbers, or if tariff rhetoric flares up once more, or if the Fed turns extra cautious, all that leverage might make a small pullback really feel quite a bit greater.
In different phrases, margin debt gained’t begin the hearth. However it can make it worse when it occurs.
So what do you have to be careful for?
If margin charges start to rise (that means lenders see extra danger) or if there’s an uptick in pressured sell-outs (margin calls), that’s the second the “grind” would possibly shift into one thing quite a bit much less pleasant.
And if the market’s upside turns into concentrated in fewer names whereas margin debt climbs, that’s one other crimson flag.
Right here’s My Take
I’m not sounding an alarm bell simply but. This chart is a warning signal, not a crimson mild.
In reality, I consider this rally can proceed, and it’s doubtless that we’re nonetheless in that “grind larger” zone.
However this chart tells us that our margin of security has thinned. The upside stays, however getting caught when the tide turns is way extra harmful than it was just a few months in the past.
It’s not a motive to desert the market, however moderately a reminder that the subsequent leg of upside would require stronger fundamentals and broader participation…
Not simply leverage and momentum.
Regards,
Ian King
Chief Strategist, Banyan Hill Publishing
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